Coordination Problem

The FSF-Nutek Award to Israel M. Kirzner

As announced last week, Professor Israel Kirzner was awarded the FSF-Nutek Award for entrepreneurship and small-business research. The announcement is now in English (here) and in Swedish (here).

Is It Time to Sell Short? Redux

NYT today reports that "American's Savings Rate at Lowest Level Since 1933."  In fact, the savings rate dipped into negative territory --- minus .5 percent.  Meaning that Amercian's spent more than they earned in after tax income in 2005.

An earlier post raised some concerns over the long term viability of the US economy given the policy path that has been followed by the executive branches of the last several administrations and also Fed policy --- which I would argue has been more inflationary than usually thought.

One of the most important contributions that the Austrian school made to 20th century economics was the development of the monetary theory of the trade cycle, and yet in the modern era the Austrian school has not devoted the intellectual attention to these issues and to making the modifications and advancements on existing theory required to bring the Austrian theory of the trade cycle into the modern conversation among economists.  Obviously, Roger Garrison, Steve Horwitz, Joe Salerno, Roger Koppl, and Bill Butos have all said very important things on the theory and empirics of the Austrian theory of the trade cycle.  And Tyler Cowen and Richard Wagner have made cogent criticisms of the theory.  But in terms of modern application to the policy world we must address today, the Austrian economists have not taken up the challenge to write beyond policy-wonk papers or op-eds, and instead offer an analysis that would engage the crowd at Brookings or NBER.  But this is what is sorely needed in my opinion.

There is a unique opportunity with the changing of the guard at the Fed, and the increasing awareness of the 'fault lines' in the modern US economy that are a result of fiscal irresponsibility and monetary expansion under the current governmental regime.

On Shakespeare, Medicine, and Orwell

The autumn 2005 issue of the excellent City Journal has a very good paper by Theodore Dalrymple on Shakespeare and medicine. Dalrymple explains how the Galenical theory of humors ruled Western medicine for hundreds of years, even though it couldn’t cure people much. Because Shakespeare had no university training in medicine, he understood well the limits and problems of the medical knowledge of his days (the same was true of French playwright Molière).

As Dalrymple argues, the parallel with today’s world is of interest. Policy makers all around the planet constantly create the problems they are trying to solve, as if a Galenical theory of policy was ruling the world. In the words of Dalrymple:

But Shakespeare was not in thrall to Galenism as was his son-in-law [Hall]: in other words, it was precisely his lack of university training that permitted him to be so acute an observer. While he needed a sophisticated basic education to be Shakespeare, the author of the plays, a university training, at least with regard to medicine, would have diminished rather than enhanced his work. A contemporary medical man can learn something from Shakespeare; he can learn nothing from Hall. As Orwell pointed out, it takes effort and determination to see what is in front of one’s face. Among the efforts required is the discarding of the lenses of excessive or bogus theorizing. When it comes to our attempts to understand the phenomena of our own society, I cannot help but wonder how many of us are in the grip of theories that are the equivalent of Hall’s Galenical theory, and whether as a result we do not prescribe the legislative equivalents of human skull, mummy dust, and jaw of pike.

For the entire article, see here. The best quote, however, is at the end of the article: “We have sunk to a depth in which re-statement of the obvious is the first duty of intelligent men.” – George Orwell

Great News About Israel Kirzner!

I have just talked to Professor Israel Kirzner this morning and he confirmed that he has been awarded the FSF-Nutek Award. This is given by the Swedish Foundation for Small Business Research and by NUTEK (a government body dealing with the development of the Swedish economy). The prize is awarded to economists and others who have contributed to the understanding of entrepreneurship and small firms.

In 2003 Professor William Baumol received the award.  Since Baumol’s interesting work on entrepreneurship is heavily inspired by that of Kirzner (and Schumpeter), it is pleasing to see that Kirzner was not forgotten. It also means that the Swedish government has an interest in the works of people who do not see much role for state intervention in the economy. For more on the prize see here.

Let’s hope this is a step towards another prize of higher significance also awarded in Sweden every year and that is long overdue for Israel Kirzner, the greatest (Austrian) economist alive… (see also here).

Thanks to Sebastian Weil of the ninja economist for the initial information.

EJW on Self-Disclosure and more ...

The new issue of Econ Journal Watch is now available and it continues to be one of the most interesting discussion platforms in economics avaiable.  Dan Klein's paper "Sense and Sensibilities: Myrdal's Plea for Self-Disclosure and Some Disclosers on AEA Members" is highly recommended.

Questions about the political culture within which the AEA structure has emerged address the broadest frame and reach back to the origins of liberalism. They open up the larger questions of who we are and what we are up to. A broad frame demands that we heed Myrdal’s call to keep the fundamental judgments and sensibilities out in the open. The surest way to achieve genuine discourse is to be upfront about where we are coming from.

Continue reading.

The issue includes several noteworthy contributions dealing with the political affiliations of AEA members, the competing explanations for the crisis in Argentina, and a response by Baumol on the issue of entrepreneurship in the textbooks.

The more critical explanation of the absence of the entrepreneur is that in mainstream economics the theory is generally composed of equilibrium models in which structurally nothing is changing. Equilibrium models exclude the entrepreneur by their very nature. She is absent from such a model because she does not belong there.

Continue reading Baumol.

Finally, the scholarly scandal that is the SSCI is once again exposed in a thoughtful correspondence from E. Roy Weintraub.  What SSCI is doing and how its activities will impact departmental rankings and measures of scholarly contribution needs to be understood by everyone in our business.

Read Weintraub.

Freedom in Firms

As I have mentioned before, last week Pete and I went to a conference on the firm, which was organized by Atlas Senior Fellow William Dennis and sponsored by Dick Cornuelle. I must give a big thank you to both of them for making this event possible; we had a great time discussing the economics and sociology of the business organization.

One of the themes that came up again and again was freedom in firms. This was, for instance, central to David Ciepley’s Critical Review paper “Authority in the Firm”, which was discussed on the first day. Ciepley argues that economics in the 20th c. poorly addressed the issue of production in firms because it could not address well the issue of authority in a planned order. In other words, one of the big problems of contemporary economics is that firms restrain freedom and this issue has been theorized away.

As Pete mentioned, Ciepley’s paper tends to confuse authority and authoritarianism. While authoritarianism implies a reduction in freedom, authority doesn’t. Isaiah Berlin made the distinction between positive and negative liberty in his famous lecture delivered at Oxford University in 1958.

As Berlin defined it, negative liberty refers to freedom from coercion. In this sense, liberty is a political concept, which can only be understood with regard to the issue of the use of violence among men. In other words, an individual is free if he can do what he wants to do with what he owns without anyone stopping him from doing so (i.e. using violence or the threat of it against him). As Herbert Spencer explained, this means that everyone enjoying negative liberty also has a duty to respect others doing the same (the law of equal freedom). For those interested in a non-utilitarian version of it, see one of my favorite books by Murray Rothbard’s, The Ethics of Liberty.

Positive liberty, alternatively, is defined as the ability to act to fulfill one’s own potential. In this sense, any restriction on one’s capacity to achieve goals is a restriction on freedom. It defers from negative liberty in the sense that it does not refer to the issue of the use of violence among men. The fact that I can’t fly to Europe flapping my arms like a bird is a restriction of my liberty in the positive sense. If somehow men could be endowed with wings, our liberty would increase. It is easy to see why Berlin had strong reservations about this view of liberty, as it could be used to provide more power to the state in order to “increase” freedom for all. One major issue is that positive liberty is not compatible with the law of equal freedom: more positive liberty for some doesn’t mean more positive liberty for all.  This is why liberty as we know and use it can only be understood in the negative sense.

Liberty is a political concept referring to the use of coercion. This gets us back to the firm. Since economists understand firms as nexuses of contracts, employees contract with the management team, who represent the equity owners, over the use of their labor services. Labor contracts are voluntary transactions within specified (by contract and/or legislation) boundaries. Employees decide to participate in the managerial plan, which is to employ labor services in order to achieve certain production processes with the aim of selling the output. The key word here is “services”. Firms only employ the services of their labor force; they don’t own their employees.

Therefore one may believe that firms imply a reduction in liberty (if employees’ choice sets are reduced) if one understands liberty in the positive sense. However, in the true sense of the notion of liberty (the negative one), there is no change. In a free market, there is no problem with freedom in firms. Employees voluntarily submit to some authority within the limits of negative freedom (it is an exchange of money against labor services) and their (true) freedom is not affected. (Even using the false concept of positive liberty, it is difficult to say that an employee’s freedom has been reduced. Indeed, contract restrictions are compensated by the increase in purchasing power obtained from salaries and wages.)

While Pete, Ivan Pongracic, and I were surprised that this debate even took place, it didn’t seem to bother the rest of the crowd. This goes to show that the idea of labor relations as alienating employees is still alive and well – especially among US academics.

Around the Blog

Two more blogs that we would like to add to our list. The famous Bob Subrick, at the Stationary Bandit (aka the “State” for those who are not economists), is one of the few Austrians that I know of who also knows how to do econometrics properly. Fortunately, he doesn’t blog about econometrics much…

Todd Zywicki was at the same conference on the firm that Pete and I went to. He regularly blogs on the Volokh Conspiracy. Everyone knows them of course. I was very impressed with Todd’s depth of knowledge. He is a professor of law and he has very good command of economics and many other subjects.

Does Management Science Have Much to Say that Economics Doesn’t Know?

I’ve just recently finished reading The Future of Work by Thomas W. Malone for the conference on the firm that Peter Boettke and I are attending tomorrow. Malone is a professor of management at the MIT Sloan School of Management and the Founder and Director of the MIT Center for Coordination Science (CCS).

The book deals with the way many firms (but not all) could and should be organized in the future. The basic idea is that more decentralized, market-like structures should be used within firms when it makes sense. Organizations should shift from the ‘command-and-control’ to a ‘coordinate-and-cultivate’ type of management.

While I am very interested in studies about firm structure (having myself done a bit of work on the subject), I often find books written with a management perspective frustrating. It is true that Malone offers an interesting framework in which he advises managers to start thinking in a different way. To make a firm more successful, he explains, managers should relinquish some of their prerogatives and let more market-oriented systems take place. This is difficult to do for most people because of the need to be in control and the idea that management power comes from the command-and-control aspect of the job.

At a fundamental level, there is not much new in this book. A lot has been written on firms and internal markets for a while (see for instance the work of Cowen and Parker on market-based management). Moreover, my frustration as an economist comes from the lack of intellectual framework. At the end of the day, it is not clear, in the book, why one should decentralize.

Austrian economists on the other hand have, to my knowledge, the best explanation: planned orders (firms) are limited in their growth by knowledge problems. In other words, the double Hayekian knowledge problem limits the possibilities for management to expand the firm’s activities without accessing knowledge that is not under its control (because most of the time it doesn’t even exist). In order to do so, the firm structure must be changed and adapted in a way that promotes entrepreneurial discovery.

If you read between the lines, you will find references to this Austrian explanation in Malone’s book (for instance on p. 93 where Malone explains that freelancers must be like entrepreneurs or on p. 165 where he states that no one at the top can ever know enough). However, the book is full of assertions that most economists would find unsubstantiated. For instance, Malone has a romanticized view of democracy and how it can be used in firms (chap. 5). He barely mentions the drawbacks of voting systems (contrary to what Malone thinks it is not true that democracy forces people to do things for the overall good) and he asserts that it is, somehow, an intermediary step between command-and-control and the market. Moreover, while he proposes decentralization, he offers little in the way of explaining how control will take place. Indeed, it is great to give incentives to people, but self-interest rules, and aligning incentives (personal and organizational) is crucial for the firm survival.

Malone offers many interesting examples and has indeed done a lot of research on the subject. The book is good for managers who have little knowledge of these issues and need guidance. However, like a lot of work in the management literature, it is poor on the ‘why’. This tells me that even at MIT (and at CCS) the focus of managerial studies is not the same as that of economics. In some ways, it is simply because they are interested in the ‘ought’, when economists are interested in the ‘is’. Still, it seems to me that economics has more to offer than management science to explain the inner world of firms.

Inelasticity, Illegality and Public Policy

Tyler Cowen points us to the forthcoming JPE paper by Becker, Grossman, and Murphy that examines how public policy toward illegal goods depends on the elasticity of demand for that good.

Using the same logic of this analysis to the issue of terrorism, Chris Coyne and I have raised doubts abouts the effectiveness of US policy in the post 9/11 world.

Blogs We Like

Our list of favorite blogs is pretty small. There are so many good things happening on the web that it is hard to keep track of everything. Over time, we will expand the list to include blogs that we follow and that participate in the great cyberspace debate on economics and the free society.

Today, we are adding Catallaxy, the Aussie site, where you’ll find the very interesting prose of Rafe Champion and his friends. I have a soft spot for Oz, paradoxically perhaps for an adopted Kiwi, but Australia has done many great things policy wise that the rest of the world should emulate. Rafe and his colleagues keep a close watch on the scene down under.

Also, we recommend the Private Sector Development Blog where Harford, Barger, Halkyard, and Rahman are doing a great job showing that the World Bank also has a strong interest in the role of the private sector (i.e. entrepreneurship) in fighting poverty.